Street Capitalist: Event Driven Value Investments

Wisdom on such diverse topics as: spin-offs, merger arbitrage, post-bankruptcy equities, global macro commentary and short ideas.

Street Capitalist: Event Driven Value Investments

Bruce Berkowitz of the Fairholme Fund on Bloomberg

On Buffett’s successor:

“He is so good at what he does, it’s almost insulting to think that he doesn’t have a reasonable succession plan. And I frankly don’t see why he should tell anyone. And even if he did not and this was the end of Berkshire Hathaway, he’s done an outstanding job for people over many decades. Nothing lasts forever. I hope Berkshire Hathaway lasts forever, but I don’t think Fairholme’s going to last forever. I think the succession plan is a bit overblown. I know it’s important–corporate governance, public company–I understand it. But I don’t think there’s going to be another Warren Buffett. There are great people at the company–many great people at the company. And I think shareholders are just going to do fine after Warren Buffett.”

Berkowitz on his outlook for the stock market:

“I am bullish on the country. I am bullish on the markets. Government has done a great job of pulling us from the precipice and saving what I consider to be the global financial system. And now, this is just a huge opportunity for Fairholme to start to do its part and help, sort of, restructure, build a more solid foundation to help companies rebuild and move forward. I think it’s a unique time. And I’m looking forward to the next few years. It’s going to be good.”

Bruce Berkowitz: The megamind of Miami

Fortune’s Scott Cendrowski has a big profile on Bruce Berkowitz and his activities at the Fairholme Fund:

Berkowitz may not be a household name to most investors, but he should be. During the past decade, Fairholme has produced an annualized return of 11.6% over a span in which the S&P 500 (SPX) has risen a paltry 0.7% a year on average. Since the fund launched in 1999, Berkowitz has beaten the market every year except one (when Fairholme was up 24%, vs. the S&P’s 29% rise in 2003), and he’s on track (up 17% through early December) to easily beat it again in 2010. “The highest compliment I can give,” says hedge fund billionaire Leon Cooperman, who got to know Berkowitz when they both invested in telecom stocks earlier this decade, “is if he called me up to recommend a stock, I would pay attention.”

The fund’s outstanding returns — along with Berkowitz’s being crowned U.S. stock manager of the decade this year by investment research firm Morningstar — have attracted a flood of new money to Fairholme. Investors have poured in more than $4 billion over the past year. And they’ve added $330 million more to his Fairholme Focused Income Fund, which launched in January. He plans to open a third fund, one that focuses on smaller opportunities, early in 2011…

Can Berkowitz continue to beat the odds? Can a single investor, even one with singular focus and discipline, successfully manage a portfolio the size of Fairholme? “It’s a challenge for any manager to take in that kind of inflow and repeat,” says a large Fairholme investor. Says another: “You hope that when you buy a manager, it’s a seasoned team. Having a one-man band can be risky.”

Berkowitz acknowledges the concerns with his usual candor. “Right now,” he says matter-of-factly, “we’re at an interesting junction point where people can’t decide whether we’re about to blow up.”

Bruce Berkowitz: The megamind of Miami (Fortune)

Whenever you read about Berkowitz these days, the articles have consistently mentioned that Berkowitz is nearing the point when many star managers end up hitting a slump in their careers — notable examples include Bill Miller of Legg Mason and Ken Heebner of the CGM Focus Fund.

For me, I could see this going either way. Most hedge fund managers complain that as they grow larger, it becomes more difficult to find good investment opportunities. To a certain extent, I think that’s true. Just looking at Fairholme’s portfolio, you’ll mostly see investments in massive financial services companies. Citigroup is the perfect example of that. If you look at the average volume for Citigroup, almost $2.6B is traded daily. For Fairholme, that kind of liquidity is great because it means they can enter and exit positions with ease. Plus, the risk/reward break down, given the liquidity must be attractive, especially if you believe Citi is worth what Berkowitz says.

The benefit to size is that Berkowitz can really invest across the capital structure and use his size to influence the outcomes of distressed situations:

Second, stockpiling cash is in keeping with Berkowitz’s plan to evolve Fairholme from a regular, stocks-only mutual fund into a more versatile distressed-asset investment vehicle, and to profit from the coming wave of corporate restructurings he anticipates. He believes that dozens of overleveraged companies will need to fix their balance sheets in the next couple of years — commercial real estate is one industry ripe for it, he says — and he wants Fairholme to be ready to step in as a Warren Buffett-style lender of last resort, with highly favorable terms for his investors, of course. As Berkowitz puts it, “There aren’t many people in the world you can call who can write a check for $1 billion today.”

So in theory, it’s possible that Fairholme will be able to cope with its increasing size. Still, I’m a bit concerned at the lack of a real investment team at work there. From the sound of the article, it really consists of Berkowitz and Charlie Fernandez plus a support staff. It’s true that the firm will hire experts to come in and advise on different industries, but I don’t know if that’s enough. A team can help provide varying perspectives which could be critical when making a bit, concentrated bet on just one sector of the market. A team might also be more helpful going forward, as Fairholme seems poised to enter more complicated areas of the market with their restructuring and bankruptcy activities.

How Prem Watsa Turned SickKids’ Portfolio Around

Prem Watsa is one investor I really look up to, I really enjoy the way he is able to pay attention and respect the macro while being a value investor. The Globe and Mail has an article today that features some of the work he did for the Sick Children Foundation:

When Ted Garrard took over as chief executive officer of Toronto’s Hospital for Sick Children Foundation last year, donations were down, investments had sagged and there was a public outcry over the $2.7-million paid to the former CEO.

Some wondered whether the foundation, one of the largest charities in Canada, would recover.

It looks now like those fears were misplaced.

According to recently released annual filings, donations have held steady at $88-million, costs are down 20 per cent and executive pay has been curtailed.

Even more stunning, the foundation’s investment portfolio generated a 41-per-cent return for the year ended March 31, 2010. That helped boost overall assets, which includes other holdings, to a record $670.2-million at year end.

So how did he do it?

Mr. Garrard credits much of the success to Prem Watsa, chairman and CEO of Fairfax (401.99-3.26-0.80%) Mr. Watsa is famed for contrarian market calls and he has been using that same approach as a volunteer at the foundation, where he has overseen investments for 15 years. “This comes naturally for me,” Mr. Watsa said in an interview.

Mr. Watsa said his investment strategy at the foundation has been fairly simple: Keep the asset mix relatively steady and look for value.

When he started at the foundation in 1995, 80 per cent of its then-$148.2-million portfolio was invested in equities. Mr. Watsa brought that percentage down slightly over the years and, in 2007, slashed it to 35 per cent, convinced the markets had peaked. Most of the remainder went into government bonds.

How Prem Watsa Turned SickKids’ Portfolio Around (Globe and Mail)

One of the things I really admire about Watsa’s approach to investing is the constant monitoring of overall market conditions and how it shapes his asset allocation break down and whether or not he hedges. I think it’s the right approach, some investors are so fixated on equities or bonds that they’ll stay in the asset even when their markets become frothy. Instead of remaining disciplined, they relax their investment standards and invest blindly. That doesn’t end well for their investors.

Warren Buffett invests in Bank of New York

Yesterday, the new 13F filing for Berkshire Hathaway (NYSE:BRK.B) came out and for the most part, I wasn’t really surprised. Warren Buffett trimmed some of his holdings but increased his stake in Wells Fargo (NYSE:WFC), Johnson & Johnson (NYSE:JNJ), and a new holding in Bank of New York (NYSE:BK).

Berkshire Hathaway Q3 2010 Portfolio

via: Dataroma

The new position in Bank of New York is really interesting to me. I have had this theory for a while now that asset management/trust banks would become attractive going forward because of their large fee income businesses.

See, for a long time, most banks operated on this 80/20 model where 80% of revenues came from interest activities (loans) and 20% came from fees (overdraft, credit card interchange, debit card interchange). But that’s changed a bit with the Durbin Amendment which is scrapping the debit card interchange fee from banks. Most bankers have publicly said that they will be figuring out new ways to make up the lost income — most likely by charging customers for things that they take for granted (free checking).

The other model though, might be to acquire financial institutions that are driven primarily by fees. There are a few ways to do this. A bank could acquire wealth management firms that are within their geography — BBVA did this when they came to Houston. Or they could acquire a trust bank, which typically has the income structure split closer to 65/35 than 80/20. We saw one of these acquisitions when M&T Bank (another Berkshire Hathaway holding) acquired Wilmington Trust in an immediately accretive deal.

So where exactly does Bank of New York fit into all of this?

Bank of New York is regulated as a bank but actually derives most of its income via fees. It acts as a custodian for financial assets. As a result, Bank of New York can charge asset management fees to clients, typically at a percentage of AUM. Plus, it can also charge clients on a per transaction basis – so if you expect an increased level of volatility going forward, then the bank should do quite well. This is a great business to be in and throws off a lot of free cash flow when times are good.

The only thing that concerns me about Bank of New York is the company itself. The business they are in is great and should have excellent prospects for the future, but historically the bank’s own results have been less than spectacular. To illustrate, look at BoNY’s EPS since 2000 versus Wells Fargo:

Bank of New York EPS versus Wells Fargo EPS (2000-2009)

Those earnings seem pretty weak, which makes me wonder about BoNY. At the same time, they have engaged in M&A over the last 10 years, which might have hurt earnings growth — especially if there were integration costs and dilution. Maybe Buffett is expecting some kind of shift in operations, much like what happened with Coca-Cola when he invested.

I’d suggest taking a deeper look at trust banks and banks that have some kind of non-interest fee stream that makes up a greater than 20% portion of their business. This looks like a really fruitful area for some of the bigger banks to do deals and might be beneficial to investors.

Jeremy Grantham on CNBC

CNBC has a great interview with Jeremy Grantham:

Grantham gives his thoughts on a wide range of topics from the Fed’s policies, US equities, emerging markets, commodities, and even farmland/timber.

Miguel Barbosa interviews Alice Schroeder

My friend Miguel Barbosa continues his interview with Alice Schroeder (Part 2 and Part 3). Here is an excerpt:

Miguel: What was it like being the world expert on Berkshire Hathaway?

Alice: I thought that it would be interesting to our retail brokers and to a limited number of institutional investors. I knew that a lot of people on Wall Street were indifferent to Warren Buffett and some even disliked him for one reason or another.

What I didn’t expect was that the new role would become huge, but it did, because, until that time, Warren had been so inaccessible. The New York Times ran a front page business section story “The Oracle of Omaha Taps a Medium on Wall Street.” For a while I had 3 people answering the phones. I can’t tell you how many phone calls just never got returned; it was like a wildfire. Thankfully, it calmed down after a few weeks.

Berkshire was a very interesting stock to follow, especially as you began to really understand it and its most important elements. Shortly after I began my new role, Warren made a series of acquisitions in the late 1990’s and early 2000’s. There was, as there still is, a fascination with the minutiae of these companies. But it seemed to me that the most important part of what he did resembled a factory-like process. What interested me was the factory.

Meeting the Oracle of Omaha (Simoleonsense)

Todd Combs of Castle Point Capital to join Berkshire Hathaway

According to Bloomberg:

Berkshire Hathaway Inc. has hired Todd Combs of Castle Point Capital to manage a “significant portion” of the investment portfolio built by Chairman Warren Buffett.

Combs, 39, issued a letter to partners of Castle Point announcing his decision, Omaha, Nebraska-based Berkshire said today in a statement distributed by Business Wire.

For three years, Vice Chairman Charles Munger and I “have been looking for someone of Todd’s caliber to handle a significant portion of Berkshire’s investment portfolio,” Buffett said in the statement. “We are delighted that Todd will be joining us.”

Buffett Names Castle Point’s Combs to Investment Post (Bloomberg)

Overall, I think that this decision makes a lot of sense. If you look at Berkshire over the course of its history, one of the common trends is a tendency to invest in financials. I’ve often wondered why this is but can speculate that it’s because insurance companies and banks tend to have recurring earnings and the threat of technological obsolescence is pretty low.

So who exactly is Todd Combs?

Combs (39 years old) runs Castle Point Capital, a long/short equity hedge fund focused exclusively on the financial services sector. Formed in 2005, the fund is based in Greenwich, Connecticut. Trident III provided the hedge fund’s seed capital in November 2005.

Here’s what Buffett has to say about Combs:

Buffett described Combs as an “all-American type” who is not the least bit interested in publicity, an attitude unlikely to shield him from it. Now a resident of Darien, Conn., Combs is by birth a Floridian who graduated in 1993 from Florida State University with majors in finance and multinational business operations.

Once out of school he worked for Florida’s comptroller and later moved to Progressive Insurance, where he was involved in the all-important activity of setting automobile insurance rates. Progressive is an arch-competitor of Berkshire’s GEICO.

…Buffett describes Combs’ record through the financial crisis as “pretty good.” Combs’ hiring, in fact, clearly indicates that Combs has had a performance with which Buffett is satisfied.

Meet the leading contender to manage Berkshire’s billions (Fortune)

Performance-wise, Todd Combs looks like a sharp financials investor. According to Bloomberg Castle Point’s fund gained 6.2 percent last year, fell 5.7 percent in 2008, rose 19 percent in 2007 and climbed 13.6 percent in 2006. If you look back over the same period, most financials-focused funds have not had that level of performance. Most took a beating back in 2007 and 2008 and have returns that are closer to the S&P over the same period, if not lower (about -5%).

One of the things I wondered about, back when Li Lu was discussed as a potential CIO candidate (he has since taken his name out of the running) was whether the penchant for betting big and winning huge would be an applicable strategy for Berkshire Hathaway. It’s a practice preached by Charlie Munger, but if you look out at what Buffett has done over the last 30 years, the only big bets have come via the form of acquisitions.

Some of the best plays from Berkshire’s investment portfolio have come from the preferred deals during the financial crisis and the convertible deals back in the 1987 bear market. In both cases, the investment returns had fixed-income properties, returns were capped for the most part, even though he could convert to equity or exercise warrants. These were mostly bets on survival, not on the overall ability for companies to thrive after crisis periods. An investor could have earned a much higher rate of return by purchasing common stocks near their all time lows during either period (similar to David Tepper), but it’s a strategy that Buffett did not pursue. I think that’s pretty telling.

Looking back at Todd Combs’ portfolio, we can see that he was not trying to bet big on any particular direction for financials. He was not doing a Michael Burry/Steve Eisman short the market and make 500% play. I think that is a quality that Buffett was looking for, someone who would perform well but not bet big. Maybe that’s due to the unpredictable nature of financial markets or maybe it’s because he wants the investment side of Berkshire to take a back seat to the operating businesses when he’s no longer around.

Some people have questioned whether investing in Todd Combs, someone with a short track record, makes any sense. To me, the fact that Combs performed so well during a period when most financials investors have gotten crushed is pretty telling. It’s not like we were looking at 5 years of performance during a bull market. So even though 5 years is typically too short of a short timespan, in this case I believe it’s enough to discern whether or not someone is a good investor.

You can view Todd Combs’ top 10 portfolio positions here:

Tom Combs Castle Point Portfolio

For a full look at his Castle Point Capital portfolio, click this link, to view a google docs spreadsheet with his entire list of positions as of the latest 13F-HR.

Or, view his portfolio embedded in the iFrame below:

The Joys of Compounding

Most new investors forget about spending time on studying compound interest. They end up thinking that the best way to get rich is to do so quickly, so they seek out opportunities where they can earn massive returns without looking at their true downside risk.

I thought the following charts from East Coast Asset Management’s 3Q 2010 letter demonstrate the power of compound interest quite well:

The Joys of Compounding

And this:

The Joys of Compounding

And of course, opportunity costs:

The Joys of Compounding

Full article:
East Coast Asset Management 3Q2010 Letter

About Me

My name is Tariq Ali, I run Street Capitalist. I recently graduated from the University of Texas at Austin. There, I stumbled onto value investing via the school library. I read everything I could and now I'm here, writing out my thoughts and investment ideas.

I have a lot of heroes when it comes to investing, it seems like every investor has some kind of niche. Some, whose books and writings have had the biggest impact on me are: Warren Buffett, Benjamin Graham, Joel Greenblatt, Seth Klarman, and George Soros.

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